Chile's Private Pensions Were Disaster For Retirees

by Manuel Riesco

The privatization of pensions in Chile enacted by the dictatorship of Augusto Pinochet in 1981 has been hailed worldwide as a success story, and President Bush recently said that it was "a great example" for social security reform in the United States.

Some champions of Chile's system make ideological arguments: It is a preferable system because it depends on private property, free choice, and personal responsibility; it links individual contributions with benefits, and personal effort with rewards. Other proponents argue on the basis of financial and actuarial calculations: At 4 percent yearly rates of return, saving 10 percent of salary throughout a career can afford a pensioner some 70 percent of salary at retirement. A recent argument has been added that seems tailor-made for U.S. consumption: The system entitles a foreign migrant worker to keep pension savings even upon leaving the country at retirement. Nevertheless, the Chilean private pension system has proven itself unable to keep its bright promises. A quarter century after its inception, most pensioners find themselves shortchanged, while the public coffers continue to carry most of the burden of federal retirement benefits.

The consensus among experts in Chile today is that the country's private pension system provides for only the upper-income minority of its affiliates. Even this group has complaints that the system is highly unsatisfactory, mainly because of the stiff fees charged by private pension administrators. Six companies administer the pensions and they have become the single most profitable Chilean industry. These companies reaped an average return on assets of over 50 percent a year from 1999 to 2003, even showing themselves to be immune to recession.

Meanwhile, recent studies by the State Regulator of the private pension administrators, Superintendencia de Administradoras de Fondos de Pensiones, conclude that over half of the affiliates of the system will never be able to save enough in their pension accounts by retirement to fund even the "minimum pension,Ó which is currently set at about $130 a month. Not only that but this majority of the workforce is not entitled to the complementary public social security "safety net" either. Two other studies by the government administrator of the public pension system Instituto de Normalizaci—n Previsional conclude that about two-thirds of worker affiliates will be unable to save enough for the minimum pension.

All of the studies concur that the government's guarantee of a "minimum pension" is ineffective, because very few affiliates in need of that guarantee will qualify for its prerequisite of 20 years' contributions to the system. Most affiliates do not apply for the non-contributive "assistance pension" offered by the state, which currently amounts to about $65 a month, because it is subject to quotas and targeted toward the extremely poor. This leaves most of the Chilean workforce with no pension entitlement at all -- except withdrawing the meager funds accumulated in their individual pension accounts.

These results have been confirmed by none other than the World Bank, an institution that during the past decades championed Chilean-style pension reforms all over the world. In a recent book, suggestively entitled Keeping the Promise, the bank acknowledges that private pension systems are not able to provide income security for old age for sizable portions of the workforce. It suggests that the state should provide some kind of basic pension entitlement that is not subject to any sort of quotas.

In the Chilean case, the crude reality that most affiliates reaching retirement age today confront is this: They have very little money in their individual accounts; they are not entitled to the state guarantee of a minimum pension because they have contributed for less than 20 years; and they are not extremely poor so they are not entitled to the government non-contributive "assistance pensions." They have also been subject to what is widely known in Chile today as "pension damage." That affects all those who were working and changed to the new system at the time the pension reform was implemented in 1981. They comprise about one-seventh of all affiliates.

Most of the Chilean workforce was forced to join the new system. All workers hired since 1981 were given no choice at all. Those who were working under a formal contract at the time of the reform were given the one-time choice to change or stay in the old pay-as-you-go system. In practice, however, most of them were induced to change to the new system by their employers and a huge propaganda campaign implemented by the dictatorship that promized better wages today and better pensions tomorrow.

The costs of transition were to be financed by privatizations, long-term public debt, extra economic growth due to optimized investment of pension funds by private administrators, and a so-called "residual" tax on wages. Arrangements for the transition to the new system specified that the state would contribute to privatized pension accounts with an amount called a recognition bond, equivalent to the past contributions to the old system.

Nevertheless, the amount of recognition bonds was calculated as the average of wages earned in 1978, 1979, and 1980, which happened to be years when wages were very depressed after the slashing of roughly half of buying power in the wake of the 1973 coup. Furthermore, contributions into the system throughout the decade of the 1980s were meager because wages were still depressed, and because unemployment reached levels of 30 percent of the workforce during the severe economic crisis that affected Chile in 1982 and lasted four or five years. For state employees, contributions into the pension accounts were further depressed during the 1980s, because the contributions were calculated over only a part of their salaries.

As a result, if two work colleagues reach retirement age in Chile today, both with the same salary and the same number of years contributing to social security, the one who changed to the privatized system back in 1981 will receive less than half of the pension amount that the one who remained in the old pay-as-you-go system will receive. This huge difference has been documented in hundreds of thousands of individual cases by the Association of Employees with Pension Damage, and their demand for reparations has been heard by parliament. A group of members of congress belonging to all political parties presented the problem to the administration, which has since started negotiations with the affected workers.

Monthly reviews of all Chilean workers' individual pension accounts provide excellent statistics of their crude labor reality. The numbers indicate that the modern Chilean workforce is composed of a huge quantity of workers who permanently move in and out of short-term salaried jobs, half of which last less than four months, and most of which last less than a year. While they are not working for a salary, Chileans survive by working on their own when they can. Currently around 10 percent of the workforce is unemployed, even according to government figures that are widely considered to underestimate the real joblessness rate. As a result, 70 percent of the workforce contributes less than six months each year into pension accounts, and over half of the workforce contributes less than four months each year. These figures also show clearly that women and the poorest workers suffer most from the lack of permanent formal employment.

In their enthusiasm to grab pension contributions, the promoters of the system did not pay much attention to the public purse. By contrast, they assured private gain since the boards of private pension companies are full of ex-Cabinet members of the Pinochet government. The old pay-as-you-go system produced a yearly surplus -- as is the case with the present U.S. system. But the fiscal consequence of the Chilean pension reform was a huge pension deficit, which has been paid for out of regular government revenues. The public expenditure in pensions has remained consistently on the order of 6 percent of Chilean GDP since 1981. It has absorbed almost one-third of the overall government budget, and over 42 percent of public social expenditures. Chile spends more public funds in the pension deficit than it does in education and health put together.

The current pension deficit is occasioned largely by the fact that most social security contributions are funneled to the new system while the current pensions continue to be paid by the state. Almost three-fifths of the public expenditures in social security are dedicated to paying for the remaining pay-as-you-go system and for the recognition bonds transferred to the new system. Another fifth is dedicated to pay the pensions of the military, who were careful to avoid the system they prescribed for the rest of the citizenry. As both these expenditures end up mainly in the pockets of the upper-income segment of the Chilean population, they manage to upset the redistributive effect of all the rest of public social expense, even though the latter is highly targeted toward the poor. An additional fifth of public expenditures in pensions go to the non-contributive "assistance pensions."

Public expenditures are so high that just keeping them at the present level as a proportion of GDP could well finance a decent universal basic pension for retirees. The present level is the equivalent of about $250 dollars a month for each Chilean over retirement age, which is 60 years for women and 65 for men. Because most of the current expense items will diminish in time and even the military should sometime be made to join the same system as the rest of Chileans, the expenditures could be redirected toward some kind of universal basic pension. Meanwhile, Chilean GDP is growing much faster than the population over retirement age. The savings in the privatized system, if reformed to impose serious competition and lower costs, could conform a good, complementary, second tier in a Chilean pension system that in the end will be recognized not as a private one, but a mixed public-private one.

But one thing is certain about the future: Most Chileans will receive the bulk of their pensions from the public pension system, just as they do today.